Bernanke Capitulates, Launches De Facto Nominal GDP Target

The only way the unemployment rate can get back to 6.5% is to close the output gap, which remains extremely wide.

In just five meetings after the Chairman stated that the view of the committee was that it would be reckless to allow for a higher rate of inflation to bring down unemployment at a faster pace, the committee raised their inflation rate threshold in order to bring down unemployment. Many will brush off the 50bps increase as immaterial but I think it is a slippery slope. If inflation were to exceed the 2.5% rate as in the past, we will likely hear that this is transitory or if unemployment were to fall below 6.5% then this would be viewed as unsustainable.

The fact is, Bernanke has a lot of wiggle room in his thresholds, and if my simple back-of-the-napkin regression analysis is correct, the Fed is going to be active in the market for many years to come. I would like to think Bernanke's intentions are pure, but I am also starting to wonder if his date with deflationary destiny is clouding his judgment. Either way it's pretty clear that he's making this up as he goes along. He admitted as much to in the first response to a question from CNBC's Steve Liesman as to why they have decided to make the guidance qualitative (emphasis mine).

Bernanke:

The asset purchases are a less well understood tool. We have -- we'll be learning over time about how efficacious they are, about what costs they may carry with them in terms of unintended consequences that they might create, and we'll be seeing how -- what else happens in the economy that can affect, you know, the level of unemployment, for example, that we hope to achieve.

As I have been saying since the Fed launched QE3 in September, the biggest risk in the markets today is a loss of confidence that Bernanke can hold this thing together. In my opinion there is a very large false sense of security that they know what they are doing and can indeed wield a wand to control asset prices. However, at the end of the day, this is still a confidence game. They can only do so if the markets believe that they can. If the markets lose faith, then all bets are off and the costs and unintended consequences could be severe.